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If you are an investor of any type, you likely have a story about the big fish that got away. Maybe it is a company that you owned and sold for a 30% gain, only to watch it go up tenfold over the next five years.

Can you imagine being someone who bought Apple (APPL) when Steve Jobs came in, and after having sold it for a 30% gain, watched it continually double over the next ten years? Or how about having owned shares in Berkshire Hathaway (BRK.A) and sold after some unknown young man took over a textile company and started spending cash acquiring unrelated businesses? If you are an investor, you likely have such a story.

I've got a few, and it looks like a new big fish that got away from me is Cobalt International (CIE). Cobalt is a company that entered the public domain with nothing but a big pile of cash and a bunch of highly prospective deepwater leases on which to drill for oil. The business model really is the essence of high risk and high reward.

The business model is to go out into the middle of the ocean and drill a well that costs over $100 million, with a success rate that is likely somewhere around 1 in 5. The prospect sizes are enormous, so if they hit oil, chances are, it is going to be a monster find. However if you don't hit oil, you have just flushed $100 million down the toilet.

The business model of Cobalt does not fit well with my investing style. I try and stick to instances where a company has measurable asset value that supports the current enterprise value and therefore, protects me from a permanent loss of capital. Of course, along with this downside protection, I want some upside potential. The concept is that if things work out on the upside that is great, but if the upside doesn't work out, I don't lose too much either. I've borrowed the concept from Hedge Fund manager Monish Pabrai, and he calls it "Heads I win, tails, I don't lose much".

Cobalt has always had the upside potential and then some, but there is no downside protection, as there is no guarantee that there is any oil on their lease blocks. So, since Cobalt violates my investing philosophy, how did I come to own it in the first place? For that, I can thank BP (BP) and their blown Macondo well which, in 2010, cratered the stock prices of every company with operations in the Gulf of Mexico. I unfortunately already owned a company focused on the deepwater Gulf of Mexico, so I was familiar with all of the players. I felt that the stock market overreacted to the oil spill, and bought a basket of Gulf of Mexico stocks that included Cobalt.

That strategy worked out well for me, and I sold the entire basket within a year for some nice gains. Cobalt worked out particularly well, as it bounced from $7 to the low teens. I wish I'd held on longer. Cobalt really got down to the business of drilling its giant set of prospects late in 2011. And the first big prospect offshore Africa is a huge success.

Here are the high level details:

The results of this wire line evaluation program confirmed the presence of a 1,180 foot (360 meter) gross continuous oil column with over a 75% net to gross pay estimate. No gas/oil nor oil/water contact was evident on the wire line logs.

The DST flowed at an un-stimulated sustained rate of 5,010 barrels per day of 44-degree API gravity oil and 14.3 million cubic feet per day of associated gas (approximately 7,400 BOEPD) with limited drawdown. The flow rate, which was restricted by surface equipment, facility and safety precautions, confirmed the presence of a very thick, continuous, high quality reservoir saturated with light oil.

Joseph H. Bryant, Cobalt's Chairman and Chief Executive Officer, said "Cameia is an extraordinary success. The results have exceeded our pre-drill expectations and have increased our confidence in our entire West Africa Pre-salt exploration inventory. We will immediately commence our Cameia appraisal program."

James W. Farnsworth, Cobalt's Chief Exploration Officer, added that "This test confirmed the presence of a world-class quality carbonate reservoir at Cameia. The presence and quality of reservoir had been our key play and prospect risk prior to drilling. Based upon our analysis of the test data, if not limited by the test equipment on the rig, we believe the well would have the potential to produce in excess of 20,000 barrels of oil per day. In addition, we have yet to drill our deeper targets at Cameia, which if successful will provide additional upside potential.

Cobalt which was trading for $7 when I bought in 2010; it is now over $30, and I have missed most of this ride. Cobalt is a bit of an extreme example, because it was such a high risk and high reward situation. However, it expresses why I'm so attracted to investing in oil and gas companies. There is no business where the value of a company can change so dramatically with one successful event. With this successful well, Cobalt has created billions of dollars in shareholder value and added multiples to its stock price. A company selling clothes or providing financial services can't double in value in one day. An oil and gas explorer can.

What I try to do to exploit this benefit of investing in oil and gas companies is to buy companies that are trading at a discount to their known reserves and production and also have some high impact exploration opportunities that could drastically increase shareholder value, if successful. That way, even if the exploration opportunities don't pan out I don't lose much money on my investment, because the already discovered reserves and production support the current share price.

I wouldn't jump into Cobalt right now after this good news, but I'd keep an eye on it. This well was just one of many that the company will be drilling that target these monster structures. What an investor might consider doing is waiting until one of these exploration wells results in a duster, after which the share price will surely decline and may present a more compelling entry point. There could be more steep changes in shareholder value in the future for Cobalt.

Source: Cobalt International Is An Example Of Why I Like Oil And Gas Producers